September 10, 2004

A Change in Industries
by Alex J. Stockham, Editor

It is no longer rare to change industries throughout a career. Some might say it’s those who don’t jump industries are the exception, rather than the rule. Private equity firms, however, tend to be led by people who have been in the industry for a fairly long time.

Boston-based Castanea Partners is different, though. The firm, which recently closed its first fund with outside investors on $207 million, was started by three professionals with no real experience in the private equity business. Although they had extensive experience in the industries in which they invest, they would be the first to admit their lack of experience in private equity.

“We probably have some concerns ourselves,” says Robert Smith, a co-founder and managing partner of Castanea. “But, I think we have a lot of investing and transaction experience. We’ve demonstrated we can build a team, source deal flow, make investments and work with those companies.”

Smith and his partner Brian Knez were formerly co-chief executive officers of publishing house Harcourt General. Before that, they ran retailer Neiman Marcus. In 2001, the two led the process that eventually sold Harcourt General to publisher Reed Elsevier. The deal was valued at $5.6 billion, including the assumption of debt. Using their profits from the sale, Knez, Smith and Paul Gibbons, who served as vice president and treasurer at Harcourt General and Neiman Marcus, started Castanea Partners with a $75 million fund to invest in small-market and middle-market companies in the retail, publishing, education, business services and consumer products fields.

“After we sold Harcourt, Brian and I decided we wanted to continue to work together, Smith says. “We realized the intellectual challenge of working with a portfolio of businesses was something we enjoyed. We wanted to replicate some of that activity through a private equity structure.”

Early on, the firm brought in Steven Berg as a partner. Berg, who previously worked at Bain Capital, supplied some of the private equity expertise needed to succeed. Both of the firm’s associates, Troy Stanfield and Suzanne Obenshain, have experience with other private equity firms as well.

When the principals of Castanea began thinking about raising another fund, they weren’t sure they even wanted outside investors.

“We didn’t have to look for capital to turn the lights on,” Knez says. “As we were developing, we wanted to have discussions with sophisticated investors who could give us advice - not to raise capital, but to sound out folks about what the market looked like and what people were doing.”

The topics discussed at these meetings ranged from how these limited partners manage their own portfolio to what limited partners think about communication with general partners and governance. Some of those sophisticated investors included Yale University and Princeton University, both of which ended up investing in Castanea’s second fund. Yale declined to comment on their investment.

As time progressed, Knez says, the investors they originally began talking to for advice started giving off the impression they might be interested in investing in a Castanea fund if given the opportunity.

“We got the sense they thought about investing in our firm if they had the chance,” Knez says. “If we were willing to think about it, they were willing to discuss it.”
One selling point the firm had for those limited partners, Knez adds, was the fact they were investing their own capital in the new fund. Another was Castanea’s intent to keep the investor base small and to include all limited partners on an advisory committee so they had access to the firm.

“We used to talk about how we like the idea of having a small group of investors that can fit around a table,” Smith says. “That made sense to us because we came from the corporate world, where you work with a small group of directors.”

Limited partners could also appreciate the experience and network Castanea’s managing partners had in the industries in which they wanted to invest. The size of deals the firm does - it invests between $10 million and $20 million per transaction - is also an area where Smith feels Castanea can excel.

“We were going to focus on the market size and in businesses where we could bring value based on our experience,” Smith says. “Value [in these investments] can be built by operational improvements. This wasn’t a case of financial engineering.”

Because the firm’s success will be based more on knowing the industries in which they invest, Smith and Knez feel their lack of a private equity background will, in fact, be beneficial.  
 
alex.stockham@privateequitycentral.net

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